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More names added to Orrstown Bank lawsuit

By JIM HOOK@JimHookPO

Updated:
03/29/2013 08:44:59 AM EDT

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The nation s sixth largest public transportation system is suing Orrstown Bank to recover more than $250,000 that the Philadelphia authority claims to have lost by investing in the Shippensburg area bank.

HARRISBURG -- The nation's sixth largest public transportation system is suing Orrstown Bank to recover more than $250,000 that the Philadelphia authority claims to have lost by investing in the Shippensburg area bank.

The Southeastern Pennsylvania Transportation Authority, leading a class action lawsuit in federal court, claims that 12 bank officers and directors successfully worked "a fraudulent scheme and course of business that operated as a fraud or deceit on purchasers of Orrstown common stock."
In its amended court complaint of March 4, SEPTA added two former bank employees, the bank auditor and underwriters to the lawsuit originally filed in May in U.S. District Court, Middle District of Pennsylvania.

Orrstown Bank raised $37.5 million from the sale of nearly 1.5 million shares of stock in March 2010 just after the bank was listed on the NASDAQ.
SEPTA purchased 14,574 shares in a bank it believed to have a "conservative, disciplined and stringent" lending policy, according to SEPTA's court documents. The bank however "sought to obscure the extent to which the loan portfolio was impaired." Within a year of the stock offering, the bank had restructured loans with two major borrowers and exceeded its lending limit with another. A third major borrower filed for bankruptcy.

SEPTA lays out the bank's "risky commercial lending relationships" totaling $70 million with regional developers -- the Azadi companies and the Shaool family, both in Hagerstown, Md.

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; Chambersburg developers Bob Hickey and Tom Mongold and Camp Hill lender Yorktown Funding Inc.
The lawsuit includes statements from six confidential witnesses -- four former bank employees and two borrowers. It alleges that the bank's public statements misled investors "about the quality of the bank's management, commercial loan portfolio, lending practices and internal controls."
The lawsuit also names the bank auditor and stock underwriters as defendants. Arguments for and against dismissal of the case are to be on the desk of Chief Judge Yvette Kane before the end of August.

Orrstown Bank has not answered SEPTA's lawsuit in court.
"We believe the entire suit is without merit, and we will continue to defend (our position) vigorously," said Mark Bayer, bank marketing director.
SEPTA operates train, bus and trolley routes in greater Philadelphia. Its billion-dollar budget in 2011 included interest earnings of $1.8 million on investments.

SEPTA bought shares of Orrstown Bank when they were worth about $27 each. The price had fallen to below $8 when SEPTA sued. SEPTA's loss is estimated at $250,404 on an investment of $369,053. Orrstown shares were trading around $15 on Thursday.

Orrstown Bank, with assets of $1.2 billion, has 21 branches in south-central Pennsylvania and a branch in Hagerstown, Md. Commercial loans comprise nearly three-fourths of its loan portfolio. Federal regulators began investigating the bank's lending in March 2011, but investors were not notified until a year later. The bank remains constrained by the consent agreements with regulators.

The bank returned to profitability in the fourth quarter of 2012, but recorded a loss of $38 million for the year, compared to a $32 million loss in 2011 and a profit of $16 million in 2010.

The overstatement of the bank's financial condition in 2010 allowed bank officials "to double their prior year bonuses, increase their salaries for 2011 and, for many, to keep their jobs," according to court documents. After federal regulators intervened, there were no bonuses in 2011 for three defendants -- President and CEO Thomas R. Quinn Jr., Chief Financial Officer Bradley S. Everly and Chief Operating Officer Jeffrey W. Embly. Everly, Embly and two senior vice presidents, not sued by SEPTA, resigned in 2012.

Two former bank employees "The loan officers who had brokered the loans unduly influenced the loan approval process such that borrowers were often portrayed as being more credit-worthy than they actually were."

Terry L. Reiber, the bank's senior vice president of business development, aggressively expanded lending relationships in Hagerstown, Md., that "became the Achilles heel of the bank," according to court documents. His customers' loan applications were generally approved by the bank loan committee "irrespective of their credit-worthiness."

Court documents detail the bank's lending to developers in Hagerstown, Md., to the "Old Boys Club" in Chambersburg and to a Camp Hill construction lender:

-- The bank hired Reiber, a member of the Washington County Planning Commission, in 2005. "He was voting on whether to approve various aspects of the Shaool family development projects in Washington County (Md.) while brokering expansions of credit through the bank." The bank extended $24 million of credit to the Shaool family from 2005 to 2008 .

-- The bank in 2007 extended $3.1 million in lines of credit to the Azadi companies and another $7.8 million in 2008. The companies in 2008 started having difficulties, which worsened in 2010 when Orrstown Bank broke its lease on the Azadi property on South Cleveland Avenue. The bank in January 2011 loaned $5.9 million more . Azadi asked for more in July 2011. A month later the bank issued default notices. Azadi was unable to pay. Alleging Azadi owed $16.3 million, the bank took him to federal court. They reached a resolution in February.

-- By late 2010 the bank had approved more than $21 million in loans to companies in which Bob Hickey and Tom Mongold were partners. The amount exceeded the bank's $19 million lending limit to related entities. Embly and Everly began exploring "work arounds" to restructure the loans to conceal the relationship. Hickey was Embly's next door neighbor and a member of the bank's Chambersburg-Greencastle Advisory Council.

-- The bank's relationship with Yorktown Funding Inc., Camp Hill, began with a $6 million line of credit in 2002 and expanded it to $9.5 million by 2009. Two former bank employees said the loans were excessively risky. Yorktown, which finances construction loans, filed for Chapter 11 bankruptcy in February 2010. Orrstown Bank two months later arranged bankruptcy exit financing of $16 million. The bank had an unsecured position on $8 million of the debt and in July 2011 announced it was charging off $8.6 million from the deal.

In August 2011 the bank announced an additional $21 million in loan losses, including $5.6 million more from Yorktown. Two months later the Federal Reserve Bank refused to approve the bank's proposed dividend to shareholders.

"The news, though shocking, only partially revealed the true state of affairs at the bank," according to SEPTA's complaint.

According to court documents, bank officers and directors failed to disclose to potential investors at the time of the stock sale:

-- Its underwriting and credit administration policies, procedures and controls were not stringent or conservative and were wholly inadequate.

-- Credit risk management practices were inadequate.

The bank also failed to maintain internal controls and programs that would identify adequate allowances for loan and lease losses. Its management of loans was insufficient because of inexperience and a lack of oversight.